Fred Foldvary on Ricardo and Marshall are Brothers

Fred Foldvary’s Editorial

Ricardo and Marshall are Brothers

by Fred E. Foldvary, Senior Editor

David Ricardo (1772-1823) was one of the great classical British economists. His main work is Principles of Political Economy and Taxation. The economic model Ricardo developed was the heart of classical theory until classical economics was overturned by the neoclassical revolution at the end of the 1800s.

Ricardo sought to determine how the output or wealth of an economy is divided into the owners of the three input-factors, land, labor, and capital goods. When settlers come to a new land, they first use the most productive land, and later settlers go to ever less productive land. On free land, all the product goes to labor and capital goods. But since there is one common wage level and a common costs of capital goods, the output of the superior land all goes to the owners as rent.

Ricardo’s theory therefore has a triangle sloping down from the best to the worst land in use, the flat bottom side being the production that goes to labor and capital goods, the sloping down top side being the total product. The triangle is the portion of wealth going to land rent. That triangle gets bigger and bigger as production moves to ever less productive land.

Alfred Marshall (1842-1924) was the great British economist who developed the supply and demand curves of neoclassical economics. The neoclassical turn emphasizes supply and demand rather than the factors of production, and it simplified economics to two factors, land and capital goods, folding in land into capital goods.

In the neoclassical school of thought, the supply curve of goods being produced slopes up, since it represents the costs of production. The lowest-costs producers are able to sell goods at a low price, and as the market price goes up, producers with ever higher costs are able to sell their goods profitably. Meanwhile there is a downward sloping demand curve, with folks buying ever more as the price goes down.

Imagine the supply curve sloping up as the demand curve slopes down. Somewhere they cross, and that is the market-clearing point that determines the market price and the market quantity sold.

The revenue from production is represented by the rectangle starting at the origin and going to the market price and the market quantity, revenue being price times quantity. That revenue rectangle is cut into two parts by the upward-sloping supply curve.

If the supply curve is drawn as a straight line, the two parts are triangles. The bottom triangle is the revenue or output that goes to pay for labor and capital goods, since these determine the supply. Where does the rest of the revenue and output, represented by the upper triangle, go?

Neoclassical economists call the upper triangle, between the supply curve and the price line, the “producer surplus.” It is the extra revenue left over after paying for labor and capital goods, which is surplus because the producers would supply the good if they just got a return for their labor and capital goods.

So who gets this producer surplus? The producers don’t receive it, because the surplus is not due to having better labor or capital goods tools, but because of locational advantages. Therefore, the surplus goes to the landlords as rent. Landlords are able to charge more rent in the more productive areas, because the more productive areas sell at the same price as the less productive areas, and the difference in revenues can be captured by the landlords as rent.

We can see that Marshall’s triangle of the producer surplus is the very same thing as Ricardo’s triangle that represents the land rent of superior lands. Marshall’s producer-surplus triangle is Ricardo’s rent triangle turned upside down. But the classical economists clearly labeled it “land rent,” while the neoclassical economists, having only “producers” in their model, call it a “producers’ surplus” even though the producers are not getting the surplus, but rather the landowners.

Karl Marx (1818-1883) recognized there was a surplus from production, but mistakenly thought it was that part of wages that was taken away by producers as profit. Henry George (1839-1897) clearly saw it as a social surplus that was being taken by the landowners, but that should instead go to society as public revenue, replacing taxes on labor and capital.

Marshall and Ricardo recognized the surplus that arises from production, and thus they are brothers in economic theory. But today’s neoclassical textbooks don’t bother to ask who gets this so-called “producer surplus”. They don’t tell students that this surplus is paid as land rent.

Millions of students are learning neoclassical economics today and read about the producer surplus. The implicit conclusion is that the producers are getting this surplus as profit. They don’t stop to think about what factor owner of production – of land, labor, or capital goods – gets the profit.

Henry George had it right. The producer surplus is really a social surplus that belongs to the people. If labor and capital are taxed, it hurts production, while if rent is used for public revenue, this has no ill effect, since the rent is a surplus rather than an economic cost of production. Once it is recognized that the producer surplus is rent, it becomes clear that this rent should be public revenue, rather than taxing labor and capital.

What is your opinion? Share it with The Progress Report!Copyright 2001 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.

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Arts & Letters

Geonomics is …

a POV that Spain’s president might try. A few blocks from my room in Madrid at a book fair to promote literacy, Sr Zapatero, while giving autographs and high fives to kids, said books are very expensive and he’d see about getting the value added tax on them cut down to zero. (El Pais, June 4; see, politicians can grasp geo-logic.) But why do we raise the cost of any useful product? Why not tax useless products? Even more basic: is being better than a costly tax good enough? Our favorite replacement for any tax is no tax: instead, run government like a business and charge full market value for the permits it issues, such as everything from corporate charters to emission allowances to resource leases. These pieces of paper are immensely valuable, yet now our steward, the state, gives them away for nearly free, absolutely free in some cases. Government is sitting on its own assets and needs merely to cash in by doing what any rational entity in the economy does – negotiate the best deal. Then with this profit, rather than fund more waste, pay the stakeholders, we citizenry, a dividend. Thereby geonomics gets rid of two huge problems. It replaces taxes with full-value fees and replaces subsidies for special interests with a Citizens Dividend for people in general. Neither left nor right, this reform is what both nature lovers and liberty lovers need to promote, right now.

more transformation than reform; it’s a step ahead. Harvard economics students this year did petition to change the curriculum, in the wake of the English who caught the dissension from across The Channel. French reformers, who fault conventional economics for conjuring mathematical models of little empirical relevance and being closed to critical and reflective thought, reject this “autism” – or detachment from reality – and dub their offering “post-autistic economics”. Not a bad name, but again, academics define themselves by what they’re not, not by what they are, unlike geonomists. We track rent – the money we spend on the nature we use – and watch it pull all the other economic indicators in its wake. We see economies as part and parcel of the ecosystem, similarly following natural patterns and able to self-regulate more so than allowed, once we quit distorting prices. To align people and planet, we’d replace taxes and subsidies with recovering and sharing rents.

a way to connect the dots. Making the cyber rounds is “The Cavernous Divide” by Scott Klinger, from AlterNet (posted March 21): “As the number of billionaires in the world expands, so does the number of those in poverty.” Duh. The yawning income gap is not news. Nearly every issue of our quarterly digest carries a similar quote. Yet the connection was worked out long ago by one of America’s greatest thinkers, Henry George, who labeled his masterpiece, Progress and Poverty. Techno- and socio-advances always enrich few and impoverish many. Yet progress also pushes up location values – the geonomic insight (is Silicon Valley cheaper now or more expensive?). Instead of taxing income, sales, or buildings, society could collect those values of sites, resources, EM spectrum, and ecosystem services via fees and dues, which would lower the income ceiling, and instead of lavishing corporate welfare, pay out the recovered revenue via dividends, which would jack up the income floor. Dots connected.

a way to connect the dots. Making the cyber rounds is “The Cavernous Divide” by Scott Klinger, from AlterNet (posted March 21): “As the number of billionaires in the world expands, so does the number of those in poverty.” Duh. The yawning income gap is not news. Nearly every issue of our quarterly digest carries a similar quote. Yet the connection was worked out long ago by one of America’s greatest thinkers, Henry George, who labeled his masterpiece, Progress and Poverty. Techno- and socio-advances always enrich few and impoverish many. Yet progress also pushes up location values – the geonomic insight (is Silicon Valley cheaper now or more expensive?). Instead of taxing income, sales, or buildings, society could collect those values of sites, resources, EM spectrum, and ecosystem services via fees and dues, which would lower the income ceiling, and instead of lavishing corporate welfare, pay out the recovered revenue via dividends, which would jack up the income floor. Dots connected.

what you do when you see economies as part of the ecosystem, following feedback loops and storing up energy. Surplus energy – fat or profit – enables us to produce and reproduce. To recycle society’s surplus, the commonwealth, geonomics would replace taxes with land dues (charged to users of sites and resources, in-cluding the EM spectrum, and extra to polluters), and replace subsidies with rent dividends to citizens (a la Alaska’s oil dividend). Without taxes and subsidies to distort them, prices become precise, reflect accurately our costs and values; then, motivated by no more than the bottom line, both producers and consumers make sustainable choices. While no place uses geonomics in its entirety, some places use parts of it, most notably a shift of the property tax off buildings, onto locations. Shifting the property tax drives efficient use of land, in-fills cities, improves the housing stock, makes homes affordable, engenders jobs and investment opportunities, lowers crime, raises civic participation, etc – overall it makes cities more livable. Geonomics – a way to share the bounty of nature and society – is something we can work for locally, globally, and in between.

more transformation than reform; it’s a step ahead. Harvard economics students this year did petition to change the curriculum, in the wake of the English who caught the dissension from across The Channel. French reformers, who fault conventional economics for conjuring mathematical models of little empirical relevance and being closed to critical and reflective thought, reject this “autism” – or detachment from reality – and dub their offering “post-autistic economics”. Not a bad name, but again, academics define themselves by what they’re not, not by what they are, unlike geonomists. We track rent – the money we spend on the nature we use – and watch it pull all the other economic indicators in its wake. We see economies as part of the ecosystem, similarly following natural patterns and able to self-regulate more so than allowed, once we quit distorting prices. To align people and planet, we’d replace taxes and subsidies with recovering and sharing rents.

shaped by reality. In the 1980′s, the Swedish government doubled its stock transfer tax. Tax receipts, however, rose only 15%, since traders simply fled to London exchanges. Fearing a further exodus, the Swedish government quickly rescinded the tax altogether. (The New York Times, April 20) That willingness to tax anything leads us astray. Pushing us astray is that unwillingness to pay what we owe: rent for land, our common heritage. Assuming land value is up for grabs, we speculate. We cap the property tax on both land and buildings and the rate at which assessments can go up; while real market values rise quicker, assessments can never catch up. Our stewards, the Bureau of Land Management, routinely sell and lease sites below market value, often to insiders, says the Government Accounting Office. Once we grasp that rent is ours to share, we’ll collect it all, rather than let it enrich a few, and quit taxing earnings, which do belong to the individual earner. That shift is geonomic policy.

what you do when you see economies as part of the ecosystem, following feedback loops and storing up energy. Surplus energy – fat or profit – enables us to produce and reproduce. To recycle society’s surplus, the commonwealth, geonomics would replace taxes with land dues (charged to users of sites and resources, including the EM spectrum, and extra to polluters), and replace subsidies with rent dividends to citizens (a la Alaska’s oil dividend). Without taxes and subsidies to distort them, prices become precise, reflect accurately our costs and values; then, motivated by no more than the bottom line, both producers and consumers make sustainable choices. While no place uses geonomics in its entirety, some places use parts of it, most notably a shift of the property tax off buildings, onto locations. Shifting the property tax drives efficient use of land, in-fills cities, improves the housing stock, makes homes affordable, engenders jobs and investment opportunities, lowers crime, raises civic participation, etc – overall it makes cities more livable. Geonomics – a way to share the bounty of nature and society – is something we can work for locally, globally, and in between.

an alternative to conventional land trusts. Just as it seems some functions should not be left to the market – private courts and cops invite corruption (while private mediation is fine) – just so some land should not be left in the market. That said, sacred sites do not make much of a model for treating the vast acreage of land that we need to use. So the usual trust model, which is anti-use and counter-market, can not apply where it’s needed most. Trust proponents worry about ownership and control – two very human ambitions – but they’re not central. Supposedly, we the people own millions acres – acres that private corporations treat as private fiefdoms – and conversely, the Nature Conservancy owns wilderness the public can some places use as parks. So, the issue is not who owns but who gets the rent – ideally, all of us.

one of many words I coined over 20 years ago: geoism, geonomics, geonomy, geocracy, etc – neologisms that later others came up with, too. CNBC once had a Geonomics Show, and Middlebury College has a Geonomics Institute. If “economy” is literally “management of the household”, then geonomy is “management of the planet”. The kind of management I had in mind is not what CNBC was thinking – top-down. My geonomics is not hands-on, interfering, but hands-off, organic. It’d strive to align policy with natural processes, similar to what holistic healing does in medicine, what organic farming does in agriculture. Geonomics attends to two key components: One, the crucial stuff to track is fat – or profit, especially profits without production, such as rent, or all the money we spend on the nature we use. Society’s surplus is the sine qua non for growth, needed to counter death – not merely more, but sustainable development, more from less. Two, the basic process to respect is the feedback loop. These let nature maintain balance automatically and could do the same for markets, if we let them. Letting them would turn our economies, now our masters, into a geonomy, our servant, providing us with prosperity, eco-librium (to coin a term) and leisure, time off – a hostile environment for economan but a cradle for a loving and creative humanity.